Annuities are the unwanted stepchild of the investment world, an insurance product that's been restructured to act as a retirement planning product. Think Cinderella, without the fairly godmother. Since they're sold through the insurance industry, conventional investment advisers and publications have little interest in providing complete information about their options and how they work. For example, annuities can pay out for variable lengths of time. Some might last only five or 10 years, while others will pay for life.
Annuities are an investment product in the form of a modified life insurance contract. You could think of the contract as having two halves: The putting money in part; and the taking money out part. You can build your annuity slowly by making deposits for decades, or buy it outright with a lump sum. You won't get a tax deduction like you do with an IRA or 401(k), but your investment will grow tax-free for as long as it's in the annuity. At some point, you begin taking an income from your annuity. That's called annuitization. You can start withdrawals immediately or at some specified point in the future.
Annuitization vs. Minimum Distributions
Annuitization is flexible and it's one of the key benefits of annuities as opposed to IRAs. With an IRA, you have to begin taking mandatory minimum distributions from your retirement plan at the age of 70 1/2. This can lead to a complicated balancing act, as you weigh your income needs against your taxation picture. With most annuities, you're not committed to specific date or age for withdrawals. You can postpone annuitization indefinitely or start taking an income at any time, though there is a tax penalty if you haven't reached 59 1/2 years of age when you withdraw funds.
Some annuity contracts are structured to pay for a fixed number of years, so they're called term-certain or certain period annuities. The insurer pays out the entire annuity over that time, in equal installments. Others are life annuities, paying for the duration of the owner's life. The insurer guarantees payments of a certain amount and will maintain those guaranteed payments even if the capital runs out. It's a form of longevity insurance and some annuities are sold under that name. Joint annuities provide income for two people. Owners can structure the joint annuity to pay until either the first person's death or the second person's, whichever makes sense in their circumstances.
Choosing Your Annuitization
Term-certain annuities are useful for specific purposes. For example, you could use one to provide child-support income until age 18, or income for a student through college. Alternatively a term-certain annuity can provide income for an early retirement, terminating when your pension plan kicks in or when you start taking income from your IRA. Life annuities are open-ended, so insurers make smaller payments from a given amount of capital. If you live longer than they expect they run the risk of losing money, which is why that calculation is deliberately conservative. You can usually name a beneficiary to receive any money left in the annuity when you die.
Fred Decker is a trained chef and certified food-safety trainer. Decker wrote for the Saint John, New Brunswick Telegraph-Journal, and has been published in Canada's Hospitality and Foodservice magazine. He's held positions selling computers, insurance and mutual funds, and was educated at Memorial University of Newfoundland and the Northern Alberta Institute of Technology.